Within a period of a few months from the time we started raising our first fund to the time of the first close, we tracked valuations at Series A moving from an average of c. $30-$60M in early 2019 to valuations of $60-$150M and Series B’s went from c. $60M to $100-$250M and above. Seed also went from <$10M valuation to rounds being raised well above $10M in and into the range of $25M. Effectively, Seed valuations started to look like Series A valuations while Series B’s even looked larger than what traditional later stage rounds looks like in MENA. The above are imprecise definitions but speak to what was a clear trend of valuation increases between 2020 and 2022.
With our target fund size of $100M, we had to make some bold and decisive choices with respect to our portfolio construction. With this current fund size, it would be difficult for us to take up meaningful (e.g. 50%) allocations of round sizes at A and B and keep our target portfolio diversification of investing in 20 companies. This proved to be the first thing that made us pause and re-consider how we were investing.
Besides fund size, something also felt instinctively remiss in the macro environment and the pricing model for these assets. We began to feel that despite all the positive sentiment, something felt off and we dug into why we thought an investment strategy focused on B might be an issue. The key question we directed our attention is not what the entry valuations should be at, but rather what a reasonable exit value might be for a successful company.
Most companies in MENA oremerging markets more broadly tend to be adaptations of global business models that have evolved and thrived in other markets, specifically the US/Europe (e.g. Careem to Uber, Souq to Amazon, Nana to Instacart, Foodics to Toast/Square).
Obviously there are a very large number of variables that go into exit valuations, but if were to normalize all other factors and focus specifically on Total Addressable Market (TAM) with GDP as an imperfect stand-in then that gives us the opportunity to do a quick and dirty analysis of what the potential outcomes of regionally equivalent companies might exit at.
The combined economies of the KSA, UAE and Egypt is roughly around $1.3 trillion. We could potentially add the rest of the GCC and we get to c. $1.8 trillion or so in GDP. US GDP alone is $25 trillion. At best, our region as a whole is about 7.5% of the TAM of the US.
I should caveat by mentioning that GDP is an extremely imperfect indicator for market size, but is the easiest/most accessible common denominator. One could also argue that the US-based companies are more global in nature and expand to Europe, LATAM and Asia and therefore their addressable market is in theory larger than regional companies that have not on the whole historically scaled outside of the MENA market (with some notable exceptions of course).
Based on the above formula of TAM being 7.5% of US, the below gives a list of US-based companies market caps and what their proportional regional variants might be valued at some terminal point in the future (e.g. at exit).
This is obviously not a representative list and is a random sampling of public companies. Although having said that, Doordash’s regional equivalent of $2.6B is uncannily quite close to Jahez’s current market cap of $3.3B.
Taking the average, we see that the regional equivalent exit should be in the $1B range. As such, investors entering at Series B at $250M and above (investing $50M) can in a best case scenario end up with a 3x return. Once you factor in dilution from further rounds pre exit (assuming another 10-20% dilution) then we start getting into the 1.75x-2.25x. This excludes failure of companies. Even at Series B companies have a roughly near 50% change of failure. Once you factor in a risk-adjusted failure rate, return across a fund portfolio with a focus on late stage at last year’s premium valuations could become very problematic very quickly.
The issue with investing at relatively later stages means that once there is a contraction in the overall multiples in the market you are left with very little room to maneuver as the overall size of the market is a larger factor than in the US. The worst thing that could happen as an investor is that from a portfolio construction perspective you invest in successful companies but due to the dynamics above you end up with lackluster performances. The companies you’ve invested in at large do well and exit but the scale and size at which they exit is commensurate with the size of the markets they operate in and as such have a natural built in limiting factor.
It would be beyond premature to announce victory and say that our approach was the winning strategy for portfolio construction. Venture is a long game and the true nature of the outcome of the strategy will be apparent in the next 4-5 years as opposed to 12 months.
Having said, our shift towards a pre-seed, seed and Series A focus will allow us to weather the coming disruption in private market valuations more effectively than others. We opted to take early stage operational risk over late stage systemic/market size risk. We saw that even if we entered at $20M as opposed to $10M at Seed, if the company is successful and the exits are in the range of $300M-$1B then it won’t matter much. As opposed to investing later, where even if we end up choosing all the right companies to invest in and partner with, the natural market size might limit our ability to generate a return.
Interestingly though we do think given strong market contraction in multiples, that entry valuations for late stage/growth stage (Series B and beyond) are slowly but surely coming down in our region. So perhaps we got the timing right for the launch of our firm’s upcoming products.
Khaled Talhouni is managing partner at Nuwa Capital